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The Optimal Level of International Reserves for Emerging Market Countries; Formulas and Applications

  • Romain Ranciere
  • Olivier D Jeanne

We present a model of the optimal level of international reserves for a small open economy that is vulnerable to sudden stops in capital flows. Reserves allow the country to smooth domestic absorption in response to sudden stops, but yield a lower return than the interest rate on the country's long-term debt. We derive a formula for the optimal level of reserves, and show that plausible calibrations can explain reserves of the order of magnitude observed in many emerging market countries. However, the recent buildup of reserves in Asia seems in excess of what would be implied by an insurance motive against sudden stops.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 06/229.

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Length: 33
Date of creation: 01 Oct 2006
Date of revision:
Handle: RePEc:imf:imfwpa:06/229
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  17. Sebastian Edwards, 2004. "Thirty Years of Current Account Imbalances, Current Account Reversals and Sudden Stops," NBER Working Papers 10276, National Bureau of Economic Research, Inc.
  18. Christian B. Mulder & Matthieu Bussière, 1999. "External Vulnerability in Emerging Market Economies; How High Liquidity Can Offset Weak Fundamentals and the Effects of Contagion," IMF Working Papers 99/88, International Monetary Fund.
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